~ Investment Strategy

Macro Diary

China is the interesting question today. Bloomberg has a piece a note from UBS, which uses a new measure of aggregate financing that the PBoC has published since September with 10 years’ back data (“total social financing”, including bank loans, foreign-currency loans, entrusted loans (?), trust loans, bankers’ acceptance bills, corporate bonds and non-financial stock sales). Bank loans are at a record low of around 55%. Having read this, I wrote two notes: “likely keeping growth strong” and “watch for crackdown”.

Evidence of a crackdown came a mere 10 minutes later as my attention turned to FT Alphaville. It summarises a note from a Nomura analyst, who has three pieces of evidence that some kind of crackdown is likely in 2013:

– PBoC said after its Dec meeting that the government should be vigilant of the risks in the financial sector.
– It then issued a statement that mentioned “four policy objectives” — the usual three of stabilising growth, rebalancing the economy and containing inflation, and a new one, “controlling risk”.
– A statement from several authorities at the end of the year observed that local government debt had risen rapidly in H2 2012 and called for various activities to be banned, including, for example, local governments providing guarantees for trust loans made to… local government financing vehicles.

Nomura suggests that total social financing growth could fall from 51% YOY in H2 2012 to 20-30% in H1 2013. This would imply a reduction in the total amount of financing provided. Since local government investment remains, I believe (need to check this), a major component of GDP growth, this could be a negative for China’s overall growth rate.

Incidentally, everybody says that the Chinese economy is rebounding. Why? Is it all about the PMI, plus some esoteric indicators like Hong Kong luxury goods sales? I am not sure. I have still to produce a Chinese data pack that will help to answer this kind of question.

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There are stories about Japan, although whether they are “news” is questionable as the direction of travel is by now well-established. Abe has revived the “Council on Economic and Fiscal Policy” which brings together politicians, central bankers and business leaders and was abolished by the DPJ. This will give him a forum in which to pressurise the BoJ to adopt a 2% inflation target. Also, the FT anticipates that Abe’s budget will include extra spending worth 2% of GDP. These two things — a more proactive central bank and increased government spending — represent two of Abe’s “three arrows” for ending deflation, the third being measures to increase Japan’s growth potential which are likely to be announced later in 2013.

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To get positively Hegelian, the two countries discussed above meet in a story about the fallout from Japan’s recent purchase of disputed islands. Never mind that the purchase was intended to prevent a worse incident, their purchase by a nationalist mayor; face matters to the Chinese and Japanese, and the Chinese have to make a fuss to avoid losing any. Bloomberg reports that that fuss has had a real effect on Japan, through a Chinese consumer boycott that began four months ago. Japanese car sales in China have yet to recover, and exports to China have fallen such that the US is presently Japan’s biggest export market.

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Why should my macro investing process work? One reason is that it means I play by reasonably clear rules. A paper by Galle and Farmer has investigated how people play simple two-player games, and concludes that people tend to play equilibrium strategies — as predicted by game theory — in simple games but that, as the complexity of games increases, players’ behaviour becomes increasingly random or chaotic. It seems to be that there is an obvious parallel with the common approach to the markets, in which players move randomly from one indicator to another, from one story to another, rather than playing a consistent game.

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Yesterday I wondered whether an improvement in the finances of state and local governments in the US might offset the effects of fiscal contraction at the Federal level. What I am really interested in is the effect on equities from a flow-of-funds point of view: will the contraction of the federal deficit, which ought to imply a contraction in the corporate and household surpluses, be offset by an increase in the state and local deficit. Stated this way, the answer seems obvious: the state and local deficit is unlikely to expand; an improvement in local-government finances would lead to a surplus, not a deficit.

I suppose my line of thought was that increased state and local government spending could add to GDP in such a way as to offset cuts at the federal level. But, of course, equities are not GDP futures, and GDP growth does not lead automatically to earnings growth. Further, the magnitude of any increase is unlikely to be enough to offset the federal cuts completely.